The Target Company and issues within their stock,

Since it's inception Eco Plastics Company has been revolutionizing plastic and and trying to do its part to save the environment. Eco's founder Marion Cosby developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for 6 years , Eco went public in 2009 and listed on the Nasdaq stock exchange.

As the chief financial officer of a young company with lots of investment oppurtunities , Eco's CFO closely monitors the firms cost of capital. The CFO keeps tabs on each of the individual costs of Eco's three main financing sources : long term debt, preferred stock, and common stock. The target Capital structure of ECO is given in weights as follows :

Source of capital

Long Term Debt..................... 30%

Preferred Stock...................... 20%

Common Stock Equity ......... 50%

Total........................................100%

At the present time , Eco can raise debt by selling 20 year bonds with a $1000 par value and a 10.5% annual coupon interest rate. Eco's corporate tax rate is 40% and its bonds generally require an average discount of $45 per bond ad flotation costs of $32 per bond. When being sold. Eco's oustanding preferred stock pays a 9% dividend and has a 95 per share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Eco is a young firm that requires lots of cash to grow it does not currently pay a dividend to stockholders. To track the cost of common stock the CFO uses the capital asset pricing model. (CAPM) The CFO and the firms investment advisers believe that the appropriate risk free rate is 4% and the markets expected return equals 13%. Using the data from 2009-2012, Eco's CFO estimates the firms beta to 1.3.

Although Eco's current target capital structure includes 20% preferred stock,the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long term 50% common stock. If Eco shifts its capital stock to debit, its financial advisers expect the beta to increase to 1.5.

A. Calculate Eco's current after tax cost of long term debt.

B.Calculate Eco's cost of preferred stock

C.Calculate Eco's current cost of common stock.

D.Calculate Eco's current weighted average of cost capital.

E.

1. Assuming that the debt financing costs do not change , what effect would a shift to more highly leveraged capital structure consisting of 50% long term debt, 0% preferred stock, and 50% common stock have on the risk premium for Eco's common stock? What would be Eco's new cost of common equity.

2.What would Eco's new weighted average cost of capital?

3.Which capital structure- the original one or this one, which is better? why?

Capital Financing and Investments (BA213) September-October 2015 UCSI UNIVERSITY FACULTY OF BUSINESS AND INFORMATION SCIENCE Assignment questions (30%) Attention: 1. The date of submission is on 23th September 2015 (Wednesday) during lecture class. 2. Late submission will be penalized (1 day late will deducting 10 marks) unless extenuating circumstances are upheld. 3. Cases of plagiarism will be awarded zero (0). 4. The assignment should be bound in an appropriate style (comb bound or stapled). 5. Assignment must be typed and printed (Font: Times New Roman; Font size: 12) 6. Assignment is a group basis (minimum is 3 members and maximum is 4 members). 7. Assignment must have a cover page consisting student names & id.s. Question 1 Diana Dennison is a financial analyst working for a large chain of discount retail stores. Her company is looking at the possibility of replacing the existing fluorescent lights in all of its stores with LED lights. The main advantage of making this switch is that the LED lights are much more efficient and will cost less to operate. In addition, the LED lights last much longer and will have to be replaced after ten years, whereas the existing lights have to be replaced after five years. Of course, making this change will require a large investment to purchase new LED lights and to pay for the labor of switching out tens of thousands of bulbs. Dian plans to use a 10-year horizon to analyze this proposal, figuring that changes to lighting technology will eventually make this investment obsolete. Diana's friend and coworker, David, has analyzed another energy-saving investment opportunity that involves replacing outdoor lighting with solar-powered fixtures in a few of company's stores. David also used a 10-year horizon to conduct his analysis cash flow forecasts for each project appear below. The company uses a 10% discount rate to analyze capital budgeting proposals. Year 0 1 2 3 4 5 6 7 8 9 10 LED project -RM4,200,000 700,000 700,000 700,000 700,000 1,000,000 700,000 700,000 700,000 700,000 700,000 Solar project -RM500,000 60,000 60,000 60,000 60,000 60,000 60,000 60,000 60,000 60,000 60,000 1 Capital Financing and Investments (BA213) September-October 2015 a) What is the Net Present Value (NPV) of each investment? Which investment (if either) should the company undertake? b) David approaches Diana for a favor. David says that the solar lighting project is a 'pet' project of his boss, and David really wants to get the project approved to curry favor with his boss. He suggests to Diana that they roll their two projects into single proposal. The cash flows for this combined project would simply equal the sum of the two individual projects. Calculate the NPV of the combined projects. Does it appear to be worth doing? Would you recommend investing in the combined project? c) Do the net present value (NPV) and internal rate of return (IRR) always agree with respect to accept-reject decisions; with respect to ranking decision? Explain. Question 2 Since its inception, Eco Plastic Company has been revolutionizing plastic and trying to do its part to save the environment. Eco's founder, Marion Cosby, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the east coast peninsular Malaysia. After operating as a private company for 6 years, Eco went public in 2012 and is listed on the Kuala Lumpur Stock Exchange (KLSE). As the chef financial officer of a young company with lots of investment opportunities, Eco's CFO closely monitors the firm's cost of capital. The CFO keeps tabs on each of the individual costs of Eco's three main financing sources: long-term debt, preferred stock and common stock. The target capital structure for Eco is given by the weights in the following table: Source of capital Long-term debt Preferred stock Common stock equity Total Weight 30% 20 50 100 At the present time, Eco can raise debt by selling 20-year bonds with a RM1,000 par value and a 10.5% annual coupon interest rate. Eco's corporate tax rate is 40%, and its bond generally require an average discount of RM45 per bond and floatation costs of RM32 per bond when being sold. Eco's outstanding preferred stock pays a 9% dividend and has a RM95-per share par value. The cost of issuing and selling additional preferred stock is expected to be RM7 per share. Because Eco is a young firm that requires lots of cash to grow it does not currently pay a dividend to common stockholders. To track the cost of common stock the CFO uses the capital asset pricing model (CAPM). The CFO and the firm's investment advisors believe that the appropriate risk-free rate is 4% and that the market's expected return equals13%. Using data from 2012 through 2015, Eco's CFO estimates the firm's beta to be 1.3. Although Eco's current target capital structure includes 20% preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long-term debt and 50% common stock. If Eco shifts its capital mix from preferred stock to debt, its financial advisors expects its beta to increase to 1.5. 2 Capital Financing and Investments (BA213) a) b) c) d) e) September-October 2015 Calculate Eco's current after-tax cost of long-term debt. Calculate Eco's current cost of preferred stock. Calculate Eco's current cost of common stock. Calculate Eco's current weighed average cost of capital. (1) Assuming that the debt financing costs do not change, what effect would a shift to a more highly leveraged capital structure consisting of 50% long-term debt, 0% preferred stock and 50% common stock have on the risk premium for Eco's common stock? What would be Eco's new cost of common equity? (2) What would be Eco's new weighted average cost of capital (WACC)? (3) Which capital structure: the original one or this one seems better? Why? 3